A history lesson on tax cuts

Memories are short, which is lucky for politicians. Consider the current debate over letting the Bush tax cuts for the wealthy expire, and the largely forgotten rationale for cutting taxes in the first place.

Hint: It wasn’t because rates were too high. It was because the surplus was too big.

Yes, too big.

President Bush laid out this reasoning in his first address to Congress, in February 2001. “Many of you have talked about the need to pay down our national debt. I listened, and I agree,” he said, vowing to eliminate $2 trillion in debt over the next decade.

Likewise, he said, the nation, like “any prudent family,” should have a “contingency fund” for emergencies. And so, Bush assured the nation, he would set aside another sum, nearly $1 trillion over 10 years.

“That is one trillion additional reasons,” he said, “you can feel comfortable supporting this budget.”

Rainy day fund

Even with that rainy day fund, and the budget growing at a comfortable 4 percent, Bush argued, “we still have money left over” for a tax cut.

“The people of America have been overcharged,” Bush proclaimed, “and on their behalf, I am here asking for a refund.”

Smart people in both parties understood, even then, that the projected surplus was uncertain; that the rosy estimates did not adequately account for the long-term needs of Medicare and Social Security; and that the true cost of the tax cut, obscured through budget gimmickry, was greater than advertised. They were right.

As it turned out, the people of America — in particular, the rich people of America — weren’t overcharged, they were undercharged. They received an unaffordable tax cut premised on the false notion of affordability.

Don’t take it from me, take it from Arizona Republican Sen. John McCain — that is McCain circa 2001 and 2003.

“I cannot in good conscience support a tax cut in which so many of the benefits go to the most fortunate among us,” McCain said in 2001.

Two years later, when the surplus had evaporated and Bush was pressing to accelerate and expand tax cuts to help the faltering economy, McCain said more benefits for the wealthy would be “irresponsible” at a time of “rising national debt.”

The deficit that year was $378 billion. What once sounded scary now seems quaint.

Today, the argument against raising top rates comes down to a tired and self-contradictory combination: First, rates can’t be allowed to rise now, with economic growth lagging. Second, rates can’t be allowed to rise ever, because of the supposed impact on — all together now — small-business job creators.

The first argument is unpersuasive because the economic drag of higher rates on the wealthiest taxpayers is far less than the impact on the middle class. The Congressional Budget Office estimates that raising top tax brackets would lower growth next year by one-tenth of a percentage point, compared to a 1.3 percentage point hit if middle-class taxes rose.

The second argument, about small business, is equally unconvincing. Despite the bipartisan idolizing of small business, it is not the engine of job creation. Start-up businesses are — at least the sliver of those that succeed.

Business income?

Even if they were the key to job growth, most small businesses — fewer than 3 percent — would be unaffected by an increase in top rates. Republicans respond that about half of income earned by small businesses comes from the top two brackets. But this is because the tax code’s strange notion of business income isn’t limited to your neighborhood dry cleaner.

Rather, it sweeps in all taxpayers with business income, no matter how small a share of earnings, along with lawyers or hedge fund managers whose firms are organized as partnerships.

Under this definition, according to the Center on Budget and Policy Priorities, 237 of the wealthiest 400 taxpayers, with incomes averaging more than $200 million, would be considered small-business owners. So would President Obama, because he receives book royalties.

These upper-bracket “small businesses” are not making hiring decisions based on tax rates. Most don’t employ anyone. According to the Treasury Department, less than 6 percent of income to taxpayers in the top two brackets went to small businesses that employ people.

Nearly a dozen years and trillions of dollars in debt since the Bush tax cuts, no one invokes the now-vanished surplus. But proponents argue with equal vigor that rates cannot be allowed to rise.